The stock market passed a crucial test last week, and now faces another one.
The S&P 500 found a strong bounce where it had to — preserving a 2½-year uptrend and allowing the steep October drop to be viewed, for now, as simply a swift correction in a slowing but abiding bull market.
Now, at about 1 percent higher from where it sits right now, the S&P 500 will confront a cluster of technical levels including its 200-day average that could define for technical traders whether this was just a bounce or something better.
Make no mistake, though, the bounce was strong. After last Monday's deeper setback to a seven-month low, the S&P strung together three straight 1 percent daily gains. As Instinet technical strategist Frank Cappelleri pointed out midweek, this had only happened three prior times since 2010 — each at important market lows (in 2011, February 2016 and June 2016).
Michael Shaoul, CEO and portfolio manager at Marketfield Asset Management, pointed out, "All we can say so far is that [last] Monday's accelerated drop lower found good support for the SPX just above 2600, and any subsequent retest should at least struggle to penetrate this level. A breach would indicate a full test of the February low at 2530 was in order, although we would use the big round number just below. If the recent bounce is to extend into November then key resistance would come into play at the 200-day [moving average] at 2765."
The market proved it could respond to severely oversold conditions and what's traditionally the strongest four-day stretch of the calendar — the final two of October and first two of November. It also benefited from a strong consensus that the passage of the midterm elections would be a bullish catalyst, and so buyers likely tried to get ahead of this expected move.
Front-running a collective belief that an election-cycle pattern will kick in might not seem the sturdiest bullish thesis. But it's also true that October's decline was exacerbated by aggressive liquidation by hedge funds racing to cut risk exposures — a process that seemed largely done by early last week.
And with the typical stock down some 20 percent and earnings coming in OK and downward revisions to fourth-quarter profit forecasts no worse than average, according to FactSet, there was also fundamental cover for rebuilding some equity exposure.
In many ways, the standard upbeat take on stocks at the late September highs — "Earnings are good, the economy humming, credit markets firm, Treasury yields not yet too high, valuations OK" — didn't change much. What did change were stock prices, to the tune of nearly 10 percent at the index level, and the investor mood which follows prices.
Cappelleri notes that the prior three-day streaks of 1 percent gains carried a bit higher in days and weeks to come but then chopped down and sideways a bit before the market resumed strong upward progress.